Internet Stocks: Nowhere to Go but Up?


All the chatter over the impending Google initial public offering, much of it negative, may be hurting Internet stocks, which have recently doing even less well than the broader market. That's the suspicion of Scott Kessler, Standard & Poor's analyst of Internet software and services stocks, who also notes that Net names tend to be more volatile.

However, Kessler sees the Google IPO as probably a worthwhile investment for investors with a long-time horizon and a tolerance for short-term volatility. As for the Internet stock sector overall, he thinks the market could be near a possible low -- and sees many stocks as reasonably valued.

These were a few of the points Kessler made in an investing chat presented Aug. 10 by BusinessWeek Online and Standard & Poor's on America Online, in replying to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat. A full transcript is available on AOL at keyword: BW Talk.

(Scott Kessler is a Standard & Poor's Equity Analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research," and then click on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts."

McGraw-Hill is not responsible for material entered into AOL except for that from persons identified as employees of McGraw-Hill or as persons authorized to act for McGraw-Hill.)

Q: Scott, the market took a welcome turn back up today. How have your Net stocks been doing?

A: The stocks I cover have fared, not surprisingly, even worse than the market in general over the past several weeks. However, my sense is that sentiment right now is approaching a possible low.

Q: How do you explain that Net stocks in general have done worse than the market recently?

A: There are probably a few reasons. The first is that these stocks tend to trade in excess of the market both on the upside and the downside, owing to their substantial volatility. Second is reflective of relatively negative sentiment regarding, in my opinion, the Google IPO, which to some extent casts a pall over the entire group. However, we believe that many of these stocks are reasonably, if not attractively, valued.

Q: What is your opinion about Yahoo! (YHOO)?

A: My recommendation on that stock is...hold. Essentially, Yahoo got out of the gates very fast in 2004 and really kicked it into another gear after posting first-quarter earnings...that I considered a blowout. Second-quarter results, while good, were not as in excess of my expectations as the prior quarter's results would have suggested. Since then, the stock has fallen pretty substantially. We continue to believe that Yahoo is an excellent way to participate in the high-growth area of Internet advertising. However, at current levels, we believe the shares are reasonably valued.

Q: What are we buying nowadays?

A: My top pick right now is...Earthlink (ELNK). The company posted second-quarter results...that notably exceeded our forecasts. Following the report, we actually raised our projections for full-year '04. Although revenue growth is relatively meager, owing to the company's sizable narrow-band Internet access business, growth is being aided by broadband revenues, and we believe will be bolstered by new offerings such as wireless services.

Our other buy recommendation is...eBay (EBAY). It has successfully transitioned to become a mainstream shopping destination and is growing nicely abroad. Having acquired PayPal some two years ago, the company is adding value with that business as well.

Other companies that I cover that I rate accumulate are Adobe Systems (ADBE), which is benefiting from the introduction of its creative suite last October and momentum in its Acrobat or electronic documents business. Another name that we like is OpenText (OTEX), which develops and sells enterprise content-management software, focusing largely on the collaboration segment. And last but not least is Priceline.com (PCLN), which we continue to like, notwithstanding some recent downward pressure affecting the segment.

Q: Scott, S&P just issued your report on the impending Google IPO -- should we be jumping in?

A: Timely question indeed. We issued Part 2 of our Google pre-IPO report yesterday, Aug. 9. The full report, and our prior Google-related publications, can be found at http://sandp.ecnext.com/ipo . But to answer your question, our recommendation regarding Google is as follows:

No. 1, we think it's worthwhile for individual investors to participate in the auction. Would-be bidders must obtain bidder IDs no later than Thursday, Aug. 12. After Aug. 12, bidders will be allowed essentially to indicate what they would be willing to pay for a specific amount of shares of Google. Now, as you may know, the company recently indicated that they expect to price their shares between $108 and $135. Based on a relative, intrinsic, and option analysis, we arrived at a fair-valued range of $121 to $127 per share.

We recommend would-be investors bid $110 per share, implying 10% upside to the low end of our fair-value range. We also recommend that investors not commit to full positions in the IPO process, thus better allowing for opportunistic dollar-cost averaging should negative volatility take the shares lower upon trading.

Q: How do you think the spread of broadband will affect Internet service providers? Any winners or losers?

A: I don't think there's any question that the increasing prevalence of and use of broadband is a net positive for virtually all Internet companies. As I indicated earlier, Earthlink is my favored play on broadband specifically. I also think content and e-commerce companies will also benefit. Overall, the faster the connection, the greater the usage and the better for most of the companies I cover.

Q: What about Barry Diller's InterActiveCorp (IACI)? Is it still a power?

A: I think the company is still a power, but if the second-quarter results and forward guidance were instructive...we now know that that company's travel business faces less favorable supply balances and more competition. And some [rival] businesses are experiencing some difficulties as well. We actually downgraded the stock following the second-quarter results, from accumulate to hold.


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